The Dirt Cheap Value Portfolio: 'Quality Rather Than Quantity'

by: Mark Krieger

When it comes to the Dirt Cheap Value Portfolio ("DCVP"), last February I had listed ten companies that were part of that "hallowed ground". Now for various reasons, the list has been whittled down to 5. With the upcoming new year, I am more interested in quality rather than quantity. The old "DCVP" is out, and a new one has manifested. Seven companies were eliminated, no longer meeting the eligibility criteria of 20% appreciation potential (one year) and within 10% of book value. Three new companies have emerged on this list, and it is with great anticipation, to see what the upcoming financial year will bring.

This is a brief recap of the companies which have fallen from the "DCVP" or were added: Imperial Sugar (NASDAQ:IPSU) was acquired and is no longer a public company. Krispy Kreme (KKD), Yahoo (YHOO), SteelCase (NYSE:SCS), and Dean Foods (NYSE:DF) appreciated so much, they no longer fall into the cheap category. Supermarket stock's SuperValu (NYSE:SVU) and Safeway (NYSE:SWY), have too much debt, union exposure and pension liabilities to be considered worthwhile. Bridgford Foods (NASDAQ:BRID) has so little float and trades so infrequently, it is no longer a practical holding. The revised "DCVP" will consist of three previous members: Luby's (NYSE:LUB), JetBlue Airways (NASDAQ:JBLU), and Pep Boys (NYSE:PBY). It will be combined with two fresh entries, Diamond Foods (NASDAQ:DMND) and Fuel System Solutions (NASDAQ:FSYS) to form the new lineup. Let the games begin.

Pep Boys: Management just announced a $50 million stock repurchase program, saying they thought their shares represented a good investment at the current depressed levels and a good use of cash. The auto parts purveyor is selling at a 2% discount to book, has $79 million in cash, and owes $200 million in debt. The company is also real estate rich, owning the real estate on 232 out of the 738 store locations it operates. It also retains four distribution centers (1.4 million sq ft), three regional offices and its 300,000 sq ft corporate headquarters complex. Weaknesses: store overcapacity and a legacy of underachieving. Target price: $14

Diamond Foods: Selling at below book value (6% discount) and beaten beyond recognition, renders this snack food maker a prime buyout candidate. All its potential bad news and then some, has been baked into its share price, as hate selling has gone unabated. This one has really only one direction to go, and that is up. Even DMND's worst critic (Jefferies) raised its price target 10%. Weaknesses: Commodity oriented, everlasting toxic perception. Target price: $19

JetBlue Airways: The airline just received an S&P upgrade from "stable" to "positive" and is cheap, selling at only 13 times 2012 estimates of 41 cents and just 9 times 2013 estimates of 61 cents. It is priced at a 17% discount to book value. The stock is well past due for a nice rally, as its shares have basically produced no appreciation in the last five years, despite vastly improved operations and liquidity. Weaknesses: The negative stigma of being associated with the airline industry, fuel exposure and debt load. Target price: $7

Luby's: The casual restaurant chain is in the midst of a successful turnaround campaign. In fiscal 2012, it was able to improve its store level profit margin from 12.7% to 15.4%, translating to a 140% earnings increase. The stock is still a bargain, at only a 6% premium to book and management has a decent 16% ownership stake (so their interests should be aligned with shareholders).

The company also possesses a impressive real estate portfolio-they own 97 of the 180 locations they operate (not including 18 food service locations). Their latest acquisition of the 23 unit chain, "Cheeseburger in Paradise" provides powerful synergy to its Fuddrucker's brand. At the present time, the company has no analyst research coverage in effect, providing the opportunity for a nice rally, once new coverage is initiated. Weaknesses: Poor shareholder relations and a history of operational underperformance. Target price: $7

Fuel Systems Solutions: The alternative fuel component supplier has a $66 million cash hoard and no debt. It sells for a 14% discount to book value, although it does have $61 million of goodwill on its books. A stock buyback implementation is a "no brainer", as the act would instill market confidence in the shares, as well as increase eps. But so far, this call of action, has fallen on deaf ears.

FSYS has seen its shares decimated lately due to losses in Italian government subsidies and foreign currency exchange ramification's. The company recently began shipping product in support of the new GM bi-fuel pick-up truck line, which management is very enthusiastic about. Earnings are forecasted to increase 150% in 2013 from 26 cents to 65 cents, implying a bargain forward multiple of only 22.

FSYS's depressed share price could also spur some M&A activity, as Westport Innovations (NASDAQ:WPRT) and Clean Energy Fuels (NASDAQ:CLNE) could be considered logical suitors. Ironic as it may seem, both these large competitors in the space, have market cap's more than four times greater than FSYS, yet they are both still unprofitable. Weaknesses: Poor shareholder relations, foreign currency exposure. Target price: $24

Bottom line: These five stocks can make you money. They possess a current total value of $50.25 and could grow 40% within the next 12 months, with the help of at least one buyout transpiring. The two most logical buyout targets are PBY and DMND. PBY had a $15 buyout deal collapse, while DMND's three largest brands (Pop Secret,Kettle and Emerald) are just too mouthwatering for the big snack outfits to pass up. The downside risk is always there, and a 20% dive is possible, but the risk reward ratio is compelling at 1:2. The ratio simply implies, the investor expects to make $2, for each $1 risked. It is time to get to work and focus on quality, not quantity.

Disclosure: I am long FSYS, PBY, LUB, JBLU, DMND. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.